Key initiatives to unlock bank lending to the European corporate sector

Transcription

1 Key initiatives to unlock bank lending to the European corporate sector Philippe de FONTAINE VIVE Vice President European Investment Bank In the wake of the crisis, the capacity of many banks to lend to relatively high risk sectors such as SMEs and young, innovative firms is seriously impaired by capital constraints and a strong deterioration in the quality of the assets on their balance sheets. Abundant liquidity alone can do little to stimulate lending as long as both demand and bank s balance sheet concerns remain unaddressed. Looking forward, as demand picks up, it is clear that the supply of bank credit could become a serious constraint on recovery. Different initiatives are needed to unlock bank lending for the corporate sector by restoring banks lending and risk taking capacity. On the one hand, concerted efforts are needed to facilitate the resolution or disposal by banks of distressed assets. On the other, measures are needed to facilitate a more effective allocation of the risks of lending to corporates, so that they do not have to be absorbed entirely by banks. These measures include the further development of credit guarantee schemes and initiatives to revitalise the securitisation market in Europe as ways of freeing up regulatory bank capital for new lending. The present and potential future role of the EIB Group as a leading European investor in the area of credit guarantees, SME securitisation and private equity investment in SMEs and midcaps is discussed. Banque de France Financial Stability Review No. 19 April

2 In Europe, bank lending plays a critical role in the financing of businesses, much more so than in some other advanced economies like the United States. This central role for bank lending goes hand in hand with the relative importance of small and medium enterprises (SMEs) within European economies. For most SMEs, banks are the only accessible form of external finance. In the wake of the crisis, however, the capacity of many banks to lend to relatively high risk sectors such as SMEs remains seriously impaired by capital constraints and a strong deterioration in the quality of the assets on bank balance sheets. Indeed, bank lending to non financial corporations is stagnating across Europe, with potential credit supply constraints only mitigated by the fact that demand for credit also remains very weak. As we look forward, it is important to recognise the potential constraint on recovery posed by the state of the banking sector. The implementation of the Banking Union is a big step forward towards the creation of strong, efficient and resilient banking sectors in Europe. As we have seen, the process of setting up the Banking Union has already been effective in encouraging recapitalisation, where needed, and in reducing uncertainty about the health of the sector. But while Europe s banks no longer look like a major source of risk, their capacity to take risks by lending to firms is impaired, particularly by high ratios of non performing loans and the extent to which these non performing loans are absorbing banks regulatory capital. A mix of strategies is needed to overcome this constraint. Much can be done, first of all, facilitate the clean up of bank balance sheets, to free up space for more lending, but this will take time. Alongside, we can also work for a more efficient allocation of risk across the financial sector, so that Europe s economies are not so dependent on banks risk taking capacity. Credit guarantee schemes offer one underused way in which both public and private investors can invest in SME risk. Further development of high quality securitisation offers another way to facilitate the sharing of SME lending risk with capital market investors, to enhance banks capacity to lend. 1 The stagnation of lending to european firms The growth of bank lending to non financial corporations (NFCs) in the European Union (EU) has declined since 2011, becoming significantly negative in many countries. Strong growth in NFC credit was brought to an abrupt halt by the global financial crisis. A modest rebound faltered in 2011 and lending to NFCs has since contracted significantly in the most crisis hit euro area countries and in euro area new Member States. In the rest of the euro area, credit growth has fallen to zero, and the pattern is similar for newer Member States outside of the euro area (see Chart 1). Currently, there is little sign of a recovery of bank credit to NFCs. Sluggish demand is the main driver of weak credit growth in the European Union, with economic activity seen as likely to remain muted in most EU Member States for the foreseeable future. With capacity utilisation already at low levels, firms are understandably unwilling to invest, depressing credit demand. In addition, high corporate debt levels in certain sectors and countries are creating pressure for deleveraging, undermining demand for credit. Chart 1 Credit growth to NFCs in the European Union (year on year, %) Feb Feb. Feb. Feb. Feb. Feb Feb. Feb. Feb. Feb. Feb Rest of euro area old Member States Stressed euro area Euro area newer Member States Source: ECB. Note: Stressed euro area comprises Cyprus, Greece, Ireland, Italy, Portugal and Spain. 82 Banque de France Financial Stability Review No. 19 April 2015

3 Chart 2 MFI total assets EU aggregate (EUR trillions) Aug Source: ECB. Feb Aug. Feb Aug. Feb Aug. While the importance of demand in explaining stagnating credit growth across the euro area is important to recognise, we also need to consider the impact of supply side constraints that have limited the ability of banks to accommodate weak demand and that have the potential to create a bottleneck for recovery once credit demand picks up. The results of the Asset Quality Review (AQR) last autumn confirm how much progress euro area banks have made in terms of balance sheet repair and consolidation over the past couple of years. Looking at the whole of the European Union, we can see that EU banks have decreased the size of their balance sheets by some EUR 5 trillion, or more than 10 percent, since May 2012 (see Chart 2). Risk weighted assets decreased even more than total assets. This reflects a shift from capital intensive corporate activity to less capital intensive sovereign lending, driven both by changes in the structure of demand for credit and by banks efforts to de risk their balance sheets to meet more stringent capital requirements. Lower risk weighted assets in combination with significant issuance of equity and other instruments, as well as capital gains from asset disposals, have boosted banks capital positions. Between 2010 and year end 2013, the Tier 1 ratio of EU banks increased by 2.6 percentage points, from 11 percent to 13.6 percent (see Chart 3). EU banks are now well placed to meet the 2019 minimum Basel III capital levels. At the same time, accommodating Chart 3 Tier 1 capital ratio (%) H Source: ECB. H2 H H2 H monetary policy is ensuring access to ample liquidity throughout the euro area banking system. EU banks thus look reasonably strong. However, significant areas of weakness and uncertainty remain. First of all, profitability remains low. While de risking and deleveraging has made banks more shock absorbent, larger balance sheets and less leverage also implies lower profitability. To return to sustainable profitability levels many banks will have to raise lending margins and adjust their business model. 1 If banks are unable to increase pricing, credit growth might be hampered. This could potentially be a source of rising borrowing costs for NFCs and could hamper credit growth. Secondly, soaring non performing loan (NPL) ratios, especially in stressed euro area countries, are raising significant questions about asset quality, and are undermining the capacity of banks to engage in new lending to the corporate sector. A recent analysis by staff at the European Investment Bank (EIB) estimates that a one percentage point increase in the NPL ratio tends to decrease net lending by around 0.8 percentage point. The ability of banks to recognise and resolve or dispose of non performing assets will be vital to ensure an adequate supply of credit to the real economy, especially once economic activity picks up. H2 European Union Non stressed euro area Stressed euro area Non euro area other Members States Non euro area new Members States H H2 1 See International Monetary Fund, Global Financial Stability Report, Banque de France Financial Stability Review No. 19 April

4 2 Supporting a more efficient allocation of risk: guarantees and securitisation With the risk taking and lending capacity of many European banks likely to be impaired for some time, even with renewed efforts to resolve the issue of non performing loans, we also need to look at what can be done to diversify sources of finance and achieve a more efficient allocation of risk. During the crisis, capital markets have to some extent offered an alternative to bank credit, mitigating credit constraints, particularly for larger firms. Net issuance of equity and debt securities by NFCs has remained positive almost throughout the crisis, the share of bonds in corporate debt increasing from 7.5% in 2008 to 11.5% at the end of However, these alternative sources of funding have still fallen short of compensating for the decline in bank lending (see Chart 4). The substitution effect only took place in countries which had relatively well developed capital market already in place before the crisis. In a context in which more stringent capital requirements for banks are likely to increase the cost of bank finance and could structurally reduce credit supply, fostering the development of more active debt and equity markets as a complement to banks could bring significant benefits in terms of system resilience and cost. However, it is important to emphasise limits to capital market based solutions in the European context. The importance of relatively small companies limits the scope of market based instruments which are generally poor at dealing with asymmetric information and are associated with significant fixed costs. Instruments to achieve a more efficient allocation of risk and enhance banks risk taking capacity include credit guarantee schemes (CGS). These provide partial guarantees on loans by covering a share of the default risk against a fee. CGSs are primarily used to alleviate constraints in access to finance for SMEs. Banks are often reluctant to extend uncollateralised credit to SMEs, even at high interest rates, partly due to the high costs of obtaining information on the true credit quality of small and/or young enterprises. As a result, SMEs sometimes fail to obtain the necessary financing even for economically and financially viable projects and CGS are used to mitigate this market failure. CGSs can also play an important role as a part of a counter cyclical public policy toolkit. During a downturn banks capital and liquidity positions are generally weakened, leading to reduced availability of credit across the economy. At the same time, Chart 4 NFC alternative sources of funding (EUR billions) MFI loans to NFCs Net issuance of quoted shares by NFCs Net issuance of debt securities by NFCs Source: ECB. 84 Banque de France Financial Stability Review No. 19 April 2015

5 heightened uncertainty increases the adverse selection and moral hazard problems embedded in SME lending, while collateral values also decrease. All these factors contribute to increasing the financing gap for SMEs, resulting in the potential for economic welfare enhancements through public sector intervention. In 2008 and 2009, the growth rate in total guaranteed volumes more than tripled to around 25% per year, from 8% in the pre crisis period. 2 This sharp increase in guarantee activity was driven primarily by crisis related measures which made up about a third of the total guarantee activity in In terms of total volumes Italy, France, Germany and Spain are the largest guarantee markets in the European Union accounting for around three quarters of total outstanding guarantees. Relative to gross domestic product (GDP), CGS coverage (see Chart 5) ranges from at or near zero (Luxembourg, Bulgaria) to over 2 percent (Italy). This range in the degree of coverage suggests that there is significant potential for the expansion of CGS in many countries. A recent survey in Eastern and South Eastern Europe implemented by the EIB under the Vienna Initiative shows that the supply of SME credit guarantees is regarded on balance as below demand in most of these countries. Support at the European level can help improving the availability of guarantees. Another potentially powerful tool to allow the European banking sector to share risk and increase capacity for lending to NFCs, including SMEs, is loan securitisation. Further development of the market for asset backed securities (ABS) in Europe has the potential to enhance the efficiency of the financial sector in Europe in a number of ways that would benefit the non financial corporate sector: Sharing risk to enhance risk taking capacity. The securitisation of otherwise non liquid loans to the corporate and household sectors allows risk to be moved off banks balance sheets and shared with investors, thus freeing up regulatory capital and enhancing bank s capacity to lend to NFCs. The securitisation of both corporate loans and residential mortgages are effective in this regard. Chart 5 Outstanding credit guarantees (% of GDP) Source: AECM. Luxembourg Bulgaria Austria Belgium Germany Croatia Greece Poland Latvia Netherlands Czech Republic Spain Slovenia Lithuania Estonia France Romania Hungary Portugal Italy Reducing fragmentation. ABSs offer a complementary way of facilitating cross border financial flows to the NFC sector, thus potentially mitigating the ongoing fragmentation of the euro area interbank market, by passing some of the risk associated with stressed euro area banks. Making lending to NFCs more attractive for banks. The securitisation of loans to NFCs, including SMEs has the potential to improve the relative attractiveness of lending to NFCs as it provides banks with a way to share specifically the risks associated with such lending. The securitisation market in Europe is relatively small and highly concentrated, with limited SME loan securitisation. The European ABS market is around one quarter of the size of the US market and is concentrated in only a few countries, notably Germany, the Netherlands and the United Kingdom. It is dominated by residential mortgage backed securities (RMBS) comprising 60% of the outstanding ABS stock. SME loan backed securities, which tend to be relatively low rated, comprise 8% of the market. Italy and Spain together account for nearly 60% of outstanding SME loan backed securities. 2 Growth in the total portfolios of members of the European Association of Mutual Guarantee Societies (AECM). Banque de France Financial Stability Review No. 19 April

6 There are a number of reasons for the relatively small size of the EU securitisation market. Investor demand for ABS has been dampened by the recession and by the reputation acquired by ABS in the wake of the global financial crisis. Cheap liquidity provision by the ECB has also limited the short term relevance of ABS issuance as a source of market funding. Inefficient and fragmented national insolvency regimes, as well as heterogeneous reporting standards and credit scoring, limit the development of the market. While a cautious and prudent approach to securitisation is needed, ongoing regulatory changes (Basel III and Solvency II) discourage investment in securitisation instruments by restraining their general eligibility for liquidity purposes, rendering them too expensive in terms of capital charges compared to other funding instruments. In this context, it is more worthwhile for banks and, to an even larger extent, insurance companies to hold SME loans rather than invest in SME loan backed securities. Unlocking the potential of securitisation will require further harmonisation and a more targeted approach to regulation. Apart from cross country harmonisation of reporting, insolvency and scoring standards, the resuscitation of the securitisation market in Europe would benefit from a more nuanced regulatory approach. Caution is warranted, especially with regard to the type of complex ABS products which have been implicated in the global financial crisis. However, regulatory reforms such as skin in the game requirements which reduce moral hazard and information asymmetries are already serving to address ABS quality issues and there is a need to avoid regulatory overshooting. In particular, the regulatory environment should make a clear distinction between high and low quality securitisation products. Reduced capital requirements for high quality, simple and transparent ABS, and their broader eligibility as liquid assets, would be important in allowing the potential of this market to unfold. Strategic investment by public institutions could also have a catalytic effect and national and European institutions could potentially act as strategic investors or guarantors through cost efficient funding structures that maximise the leverage of private resources and ensure genuine risk transfer to private investors. 3 Stepping up action at the european level As we look forward, the prospect of a continued stagnation of bank lending should be a cause for great concern. The capacity of many banks to lend to relatively high risk sectors such as SMEs, and particularly to young, innovative firms, is seriously impaired by capital constraints and a strong deterioration of the quality of the assets on their balance sheets in the post crisis period. If the dependence of European firms on bank lending continues, and if banks are unable to fully recover their capacity to provide the finance that European firms need, the result will be a further constraint to the already very weak European economic recovery. We need strong, efficient and resilient banking sectors in Europe, not least because of the size and economic importance of our SME sector. While the Banking Union is a big step towards achieving greater resilience, we also need to help improve banks risk taking capacity and their room for new lending. Alongside the need to facilitate the clean up of banks balance sheet, there is a complementary need in Europe to achieve a more efficient allocation of risk, helping banks to share part of the risks of lending to SMEs with a wider range of investors. The further development of credit guarantee schemes is one way of doing this. Facilitating a greater development of high quality securitisation in Europe including SME loan backed securitisation is another, giving capital market investors a direct way to invest in SME risk, and catalysing a greater flow of credit to this vital economic sector. In this regard, the EIB Group the European Investment Bank (EIB) and European Investment Fund (EIF) has an important role to play. In fact we are a European leader in financing SMEs and midcaps and this is one of our Group s top priorities. We are responding to the need of SMEs and midcaps for continuous and affordable finance: with dedicated products including loans, equity and mezzanine investments and guarantees/ counter guarantees; 86 Banque de France Financial Stability Review No. 19 April 2015

7 through a diverse range of intermediaries that are our financing partners in local markets all around Europe, including banks, public and promotional banks, other financial institutions, leasing companies, microfinance institutions and private equity funds; by providing the right financing for all stages of business development, such as business start up and early stage risk finance, microfinance loans, loans to support growth related investment in tangible and intangible assets and working capital; and by increasing the volume of our activity, further diversifying our product range and mobilising additional bank lending to SMEs. Enhancing access to finance for SMEs and midcaps accounts for more than 20% of EIB lending, as well as being the focus of the EIF SME lending amounted to EUR 18.5 billion, a 53% increase on The EIF, as the EIB Group s risk financing arm, boosts SME access to credit through credit guarantees, securitisation and equity finance. Total EIF guarantees and securitisation financing amounted to EUR 1.8 billion in This includes funds managed under joint initiatives with the European Commission: Competitiveness and Innovation Framework Programme (CIP) EU Guarantees (SMEG), Joint European Ressources for Micro to Medium-sized Enterprises (JEREMIE) and the Risk Sharing Instrument (RSI). The EIF provided a record EUR 1.47 billion to seed, venture and growth capital funds in But it is also clear that the scale of the challenge facing Europe s companies requires a further intensified response on many fronts. These include both regulatory reforms and expanded catalytic financing for SMEs and mid caps to overcome the financing constraints and the current lack of investor confidence in the economic outlook for these companies. This is why the European Fund for Strategic Investment, set up by the EIB and the European Commission, contains a EUR 5 billion SME window expected to support total investments of around EUR 75 billion. This financing is complementing and extending the EIB Group s existing financial support for SMEs by offering lower volume but higher risk bearing financial products ranging from high risk senior debt to equity. It is being implemented by scaling up products already available under the EIF mandates. These include Risk Capital Resources, the Competitiveness for SMEs (COSME) programme and the EIB EC InnovFin initiative which will target innovation and research from the SME level to major projects and encompanses the Risk Sharing Instrument that provides guarantees to intermediaries on new loans to innovation focused SMEs. This approach, based on higher risk bearing products that can have a larger catalytic effect in terms of the additional private finance and investment they stimulate, is all important in the current economic environment. It is adapted to the challenges posed by the current investment environment of ample liquidity but high levels of uncertainty, a lack of investor confidence in the prospects for Europe s companies, and the impaired risk bearing capacity of Europe s banking sector. Banque de France Financial Stability Review No. 19 April

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